ABOUT MICROFINANCE
What is microfinance?
Microfinance is the provision of financial services on a small scale to low-income individuals, mostly in developing countries. Business loans, often under $1000, are the most common type of financial service offered by microfinance institutions.
Why do low-income individuals in developing countries need loans?
Since there is very little opportunity for formal employment in developing countries, most people earn a living by initiating their own revenue-generating activities: farming, rearing livestock, keeping small shops and restaurants, producing clothing, and so forth. Like any business, these endeavors need capital, usually in large lump sums, in order to grow. Microfinance loans offer households a chance to access the lump sums needed to purchase the assets - a high-yielding dairy cow, bulk purchase of materials, a sewing machine, etc. - that can increase production and incomes substantially.
Why do these individuals not save the necessary amounts, instead of borrowing?
Though not impossible, it is exceedingly difficult for households in developing countries to save lump sums large enough to buy productive assets from their current earnings. In the poorest parts of the world, customers typically pay for their purchases on credit, in tiny amounts, and these trickles of income are used first for family consumption needs, such as food, and medical care.
Why not provide an outright donation, instead of a loan?
Many people do not wish to accept charity, and view a loan as a mutually beneficial alternative that is more dignified than a handout. Providing capital as a loan that must be paid back helps ensure that it is used to build a business that will continue to generate income over the long term. Finally, providing loans instead of donations better incentivizes the building of profitable, self-sufficient businesses.
This sounds good in theory. How well does microfinance work in practice?
This question has been much debated recently. Much of the debate is due to the difficulty of statistically “proving” that microfinance loans reduce poverty. The problem with statistical studies is the standards for what constitutes “proof” can be set so high that they are very difficult to meet, even when the hypothesis one is testing is true. (See the MyC4 blog post Due Diligence - Current debates on Microfinance for an excellent overview of this debate.)
There are countless real-life examples of low-income individuals who have successfully used microfinance to grow their businesses and lift their families’ living standards. Here are some of our favorites:
Ndeye Bineta Sarr, Senegal: Clothing Design
Wanjira and James Ngure, Kenya: Greenhouse Horticulture
For first-hand accounts from our clients of how microfinance loans have improved their lives, please see ourTestimonials page.
The extent to which a microfinance loan improves incomes also depends on how the loan is priced. High interest and fees can take a big cut out of microfinance clients’ profits, undermining the beneficial impact of the loan.
What do microfinance loans typically cost for borrowers?
Interest and fees charged by microfinance institutions vary widely, and may reach 100% or more of the loan amount at annual rates. Though data on the global average cost of microfinance is scarce, interest and fee rates of 30% to 40% are typical. The average interest and fee rate charged by microfinance organizations that fund loans through the popular microlending website Kiva is 35.21% (January 2010 figure, from http://en.wikipedia.org/wiki/Kiva_(organization)).
See Why Zidisha? to learn how Zidisha’s peer-to-peer lending approach reduces the cost to borrowers.
How can I learn more?
We’ve found the following online resources to be especially helpful in learning more about microfinance:
Wikipedia: Microfinance. A comprehensive overview of the history and current status of the microfinance industry, including a balanced presentation of debates among microfinance practitioners.
Kiva: About Microfinance. An excellent presentation of the case for microfinance as an effective poverty-fighting tool, including videos, statistics and quotes from leading microfinance experts and microfinance clients.
Microplace: Understanding Microfinance. A concise, well-organized collection of articles that elucidate the history of microfinance and several of the most debated questions surrounding microfinance.
Entrepreneur: Is Microfinance for You? A short, readable presentation of various issues that participants in microfinance lending should consider, and comparison of the three main microlending platforms Kiva, Zidisha and Microplace, from Entrepreneur Magazine.
Microfinance Gateway: What is microfinance? This article includes clear summaries of microfinance’s role in international development, the various business models adopted by microfinance organizations, and the reasons traditional microfinance organizations charge high interest rates.
The Grameen Foundation: Microfinance Basics. A brief and readable overview of the Grameen Bank’s model of microfinance, including a discussion of training and other client support services that may be provided in conjunction with microfinance, and the benefits of targeting women.
Opportunity International: What is Microfinance? This overview focuses on the scale of unmet demand for microfinance services, and the challenges microfinance institutions face in reaching those not yet served in a financially sustainable way.
USAID IMPACT blog: Rural and Agricultural Finance in the Spotlight at Cracking the Nut Conference. An interesting overview of some of the recent innovations in bringing financial services to remote rural areas, including mobile phone-based payment transfers and “nano-credit unions.”
The MIX (Microfinance Information eXchange) This is the largest source of individual and aggregate performance data on microfinance institutions worldwide.
State of the Microcredit Summit Campaign Report. This is an annual report on progress toward the Microcredit Summit Campaign’s goal of extending microcredit access to more than 175 million of the world’s poorest families. A comprehensive and up-to-date overview of progress made by microfinance organizations in reaching the poor.
We welcome additional nominations! If you discover other sources of information that you’d like to share with our readers, please email your recommendation to us at [email protected].